WEAKNESSES

Electronic sector dependent on the imports of a single Swedish company

Eastern mostly Russian-speaking regions lagging behind

Dynamic internal demand

After two years of subdued economic growth, because of the collapse of the Russian market and the impact on public spending of the interruption in European funding between two programmes, activity is expected to accelerate in 2017. Household consumption (53% of GDP) will continue to be the main growth driver. The increase in pensioner benefits and family allowances, rising employment, higher wages resulting from a decline in the economically active population and another increase in the minimum wage are expected to offset the hike in indirect taxes on alcohol, tobacco, fuel and the accommodation services. With the return of European funding, public infrastructure investment will continue its recovery, as will private investment in equipment because of the high production capacity utilisation rate in response to strong external demand, which absorbs 70% of industrial production. Moreover, businesses are enjoying tax exemption on their reinvested profits. Exporters finally digested the impact of the Russian recession and counter-sanctions. Dairy products, fish and alcohol, which Russia was fond of, have found substitute markets, in Scandinavia, but also outside Europe, helped by the depreciation of the euro. Wood, unprocessed wood or as wooden parts for housing construction, furniture and bedding have found buyers in Denmark and Sweden but could be hit by the depreciation of UK sterling. The Swedish company, Ericsson, continues to buy Estonian telecommunications equipment. Dwindling numbers of Russian and Finnish tourists are to a large extent offset by higher numbers of German, Lithuanian, Norwegian and Asian visitors. In contrast, rail and road transport is suffering from the drop in equipment transhipment to Russia, especially with Russia favouring its own ports.

Excellent public and external accounts

The new government team is not likely to significantly alter the excellent position of the public finances. Higher current spending and the continued increase in defence spending will only result in a small deficit financed by reserves which, moreover, exceed the amount of debt.

The trade deficit (4.3% of GDP in 2015) is broadly offset by the surplus on services, especially IT, technology or freight forwarding services (8.4% of GDP). Dividend repatriation by Swedish, Finnish and Dutch investors, strongly represented in the retail, real estate, finance and industrial sectors, are only slightly above the returns on Estonian investments abroad. Expatriates' remittances equal those of foreign workers in Estonia. European structural funds directed towards investment represent an average annual amount of 3% of GDP. The considerable foreign direct investments are balanced by no less significant Estonian direct investments and portfolio investments abroad by Estonian pension funds. External debt represented 79% of GDP at end June 2016, excluding intra-group debt related to foreign direct investments. Almost half corresponds to bank commitments, chiefly in the form of deposits made by Swedish banks in their local subsidiaries. As the public share is small, the balance is, therefore, made up by non-financial sector private debt. In addition, the debt is more than offset by the foreign assets of pension funds.

A sizeable Russian minority, but energy independence

Following a vote of no confidence in November 2016 after disagreements over economic and social policy, Taavi Rõivas and the centre-right, liberal Reform Party in power since 2001, have ceded power to a coalition formed around the leader of the Centre Party, Jüri Ratas. This coalition also includes the Social Democrats (SDE) and the conservatives of the Pro Patria and Res Publica Party (IRL), incidentally members of the previous government. This new coalition was made possible by the change of leadership within the Centre Party, the political representation of the Russian-speaking minority (1/4 of the population) whose previous leader was deemed pro-Russian and anti NATO, so not suitable. While pro-European policy and firmness towards Russia will remain, fiscal and social measures will probably be introduced with the aim of boosting growth. The country enjoys relative energy independence thanks to the exploitation of oil shale, of which the country is the world's leading producer and which covers a large part of Estonia's electricity needs. Furthermore, even if Russian gas only meets 10% of the country's energy needs, the country is connected with the Lithuanian gas terminal at Klaipeda, which covers almost 30% of its gas consumption. The business climate is excellent. The level of digitisation is highly advanced.